Pensions

We’re all living longer, more active lives. Surely, worse than being afraid of dying too young must be the fear of living too long!

So, what should you do about planning for retirement and why is it so important to plan?

Britain has an ageing population and we all can expect to live longer than our forefathers.

The number of babies born each year remains constant whilst there are more and more pensioners relying on a smaller and smaller workforce to fund their State pensions. The single persons’ current basic State pension is just £90.70 a week (2008-09 figures), and that figure is set to fall in value compared to earnings in coming years. On top of this there will be less and less State pension money available to go around.

It is vital that we all make extra provision for our retirement through some form of savings vehicle. To encourage people to save for retirement, the Government allows very generous tax breaks on pension contributions. Basic rate taxpayers receive tax relief at 20% and higher rate taxpayers can receive relief at up to 40% (although higher rate taxpayers will not necessarily get 40% relief on single contributions). It makes sense to take advantage of a pension, one of the most tax-efficient ways of investing you will ever find. If you have an existing personal pension, when was the last time you had a Personal Pension Review?

The worst thing about pensions is their name. It conjures up all the wrong pictures. Instead, think of it as something that will pay you for not working later.

Personal Accounts

From 2012, all employers must offer a quality private scheme or subscribe to a Government backed NEST. Follow the link to our sister site for full information.

What type of pension scheme should I invest in now?

If you are employed and your employer runs a company pension scheme it almost always makes sense to join it especially if your employer makes contributions in addition to your own. If your employer does not offer a company pension scheme, or if you are self-employed, you should consider a Stakeholder or personal pension plan.

If you are employed, you may be able to persuade your employer to make contributions too.

You can contribute to as many Stakeholder or Personal Pension plans as you like as long as you do not exceed the maximum levels for contributions set by the Inland Revenue.

Stakeholder pensions were introduced in April 2001 to encourage those on lower incomes to make private provision for their retirement. They are generally available to anyone based in the UK. Stakeholder pensions are available for both employed and self employed people. For the first time, those without earned income, including children (or someone on their behalf!) are able to save into a pension plan. Most employers are obliged by law to offer a Stakeholder pension scheme to employees unless they already offer a pension scheme which meets certain standards.

The aim was that Stakeholder pensions will be straightforward, low-cost, flexible and transparent. The rules state that pension providers cannot charge plan holders more than 1.5% for the first ten years, then 1% in subsequent years.

Unfortunately, the very people that these plans were designed to help have been less than eager to participate and the more affluent have been quick to use them as very efficient tax planning tools to provide pensions for grandchildren!

How much should you contribute?

This depends on your age; be realistic. If you pay £50 a month into a pension, then do you really think it will provide an income of £20,000 a year when you retire? The arithmetic just isn’t there! The most important thing is for you to increase your contributions as your earnings increase.  If you wish to maximise your occupational pension scheme benefits you can do so by contributing to an Additional Voluntary Contribution (AVC) scheme run by your employer or a Personal Pension plan. The maximum contribution that can be paid to all schemes is your annual earnings, up to the £235,000 cap.

What income can I look forward to?

From a traditional occupational final salary scheme, also known as ‘defined benefit’, the amount of income you can expect each year is worked out using a set formula. The company might pay you, say, 1/60th of your final pay for every year you have worked there. For example, if you have worked for 25 years and your final salary is £25,000, you will receive 25/60ths of £25,000, which is £10,417 a year.

If you are in an occupational money purchase scheme, also known as ‘defined contribution’, your contributions and those made by your employer on your behalf are invested in funds, usually linked to the stock market. The return on your investment depends mainly on the performance and the type of funds you have chosen to invest in. The same applies with Stakeholder and Personal Pension plans. As with any long term investment, the value of funds can go down as well as up and past performance is no indication of future performance.

The Pensions Service have developed a guide and you can access it by following this link

Which is the right choice for me?

If your employer offers a company scheme which they pay into on your behalf, in most cases you should join it. Otherwise a Stakeholder or a personal pension plan is a sensible method of funding for retirement as these schemes will give you choices to match your preferences. You can also set up different types of pension plans should you want to, which was not allowed pre April 2006.

The sooner you get started making realistic pension contributions, the more comfortable your retirement is likely to be. The pension’s world remains complex and baffling for many consumers. Choosing the right pension provider, the most appropriate funds and agreeing an affordable level of contributions can be difficult to decide by yourself. Under the simplified pension regime from 6th April 2006 (A-Day), the limits to all pension arrangements in terms of what can be paid in and taken out have changed completely. We will be able to tell you whether and how these changes impact on you and if you need to take any action to protect your pension provision.

What if I already have a Personal Pension Plan?

A pension plan is an investment like any other, just with different tax breaks and conditions. Many people still have funds with providers that are now closed for new business and are paying charges way in excess of the Stakeholder standard and/or are in poorly performing funds or closed with profit funds which are paying virtually no bonus at all. Our section on With Profit Bonds gives some background to this problem.

Independent advice is essential here as a specialist can analyse your charges and funds and make recommendations for you to move your funds - often at no cost at all to yourself.

When must I take my benefits and how will they be paid?

Some important changes were made to the pension benefit rules from 6 April 2011. In particular is the welcome news that pensions and lump sums no longer have to be taken by age 75. New income drawdown rules replace the existing unsecured pension (USP) and alternatively secured pension (ASP) rules, which have been abolished.

A new type of income drawdown, known as flexible drawdown, is available for those who meet the new minimum income requirement (MIR). Existing USP and ASP cases will be gradually moved fully onto the new basis under transitional rules. All is not good news, however as the death benefit rules, and aspects of their tax treatment, have changed.

After 5 April 2011, benefits don't have to be taken from a registered pension scheme by the age of 75 - they can just be left in the scheme as unused funds until the member needs them. Where scheme rules allow, this gives members the flexibility to delay taking their pension or tax-free lump sum until after age 75 - potentially even continuing a phased retirement strategy into their 80s or beyond.

However, the benefits still have to be tested against the lifetime allowance by age 75 (as a benefit crystallisation event). So even though the member may not be taking anything from their fund, if those unused funds are greater than the remaining lifetime allowance, a lifetime allowance tax charge will have to be paid. Any lifetime allowance charge incurred at age 75 would be at the rate of 25%, with the residual excess fund retained in the scheme to provide taxable pension income.

This also means that lump sum death benefits paid after age 75, even from unused funds, will be subject to the 55% tax charge - unless it's a charity lump sum death benefit (which can be paid tax-free).

On 6 April 2011, the unsecured pension (USP) and alternatively secured pension (ASP) rules were replaced by a new single set of income drawdown rules that are similar to the current USP rules. The key features of the new rules are as follows:

Income Limits

• The highest income allowed in a pension year is 100% of the basis amount from the Government Actuaries Department (GAD) tables at all ages (down from the 120% USP limit, but up from the 90% ASP limit).
   

• The lowest yearly income allowed is nil (the same as the USP rules, but significantly more flexible than the 55% minimum that had to be taken under the ASP rules).
   

• Those who meet the new minimum income requirement (MIR) may also have the option of flexible drawdown, which allows unlimited income to be taken at any time. At the moment you must have an income, before drawdown, of > £20,000 per annum.

The GAD tables have been updated to reflect recent mortality improvements and extended to cover ages after 75.

Income Reviews

Until age 75, the income limit must be reviewed at least every three years. Previously this was every five years. Once over 75, the limit must be reviewed every year.

Death Benefits

For deaths after 5 April 2011, any lump sum death benefit paid from an income drawdown fund (or after age 75 from unused funds) are taxed at 55% (up from the 35% that previously applied under USP). Lump sums paid on or after 6 April 2011 as a result of a death in USP before then will still be taxed at 35%.

However any lump sum death benefit is still tax free if paid from uncrystallised rights but is normally taxed at 55% if paid from crystallised rights (such as income drawdown funds or a value protected annuity). The only exception is for charity lump sum death benefits, which can be paid tax-free from crystallised rights.

Where the individual dies after age 75, then the lump sum death benefit paid after 75 (including those from unused funds) is taxed at 55%.

People already in unsecured pension (USP) or alternatively secured pension (ASP) before 6 April 2011 will be moved fully onto the new income drawdown rules over a period of up to 5 years.

Inheritance Tax (IHT)

Before 6 April 2011, pension rights could create IHT liabilities - albeit only in fairly limited circumstances. Two significant changes were made from 6 April 2011 that make the risk of IHT charges even smaller:

• The abolition of the ASP rules mean that the IHT charges that previously applied on death in ASP don't apply for deaths after 5 April 2011.
   

• The ability for HMRC to levy IHT where they consider that someone has deprived their estate through an "omission to act" (for example, by delaying taking their pension) has been removed for omissions after 5 April 2011. 

Taking Benefits Early

Every year one delays taking a pension may well mean that the fund continues to grow, but we can never, ever, live that year again and benefit from the income lost. For many people, taking benefits early makes good sense and we have developed a calculator to illustrate how this could affect you. If you would like us to discuss this with you, please contact us.